Abstract

http://ssrn.com/abstract=1164342
 
 

Citations (14)



 


 



Tractability in Incentive Contracting


Alex Edmans


London Business School - Institute of Finance and Accounting; University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Xavier Gabaix


New York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

April 25, 2011

Review of Financial Studies, Forthcoming

Abstract:     
This paper develops a framework that delivers tractable (i.e. closed-form) optimal contracts, with few restrictions on the utility function, cost of effort or noise distribution. By modeling the noise before the action in each period, we force the contract to provide correct incentives state-by-state, rather than merely on average. This tightly constrains the set of admissible contracts and allows for a simple solution to the contracting problem. Our results continue to hold in continuous time, where noise and actions are simultaneous. We illustrate the potential usefulness of our setup by a series of examples relating to CEO incentives. In particular, the model derives predictions for the optimal measure of incentives and whether the contract should be convex, concave or linear.

Number of Pages in PDF File: 31

Keywords: Contract theory, executive compensation, incentives, principal-agent problem, closed forms, multiperiod contracts, multiperiod games.

JEL Classification: D2, D3, G34, J3

Accepted Paper Series


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Date posted: July 22, 2008 ; Last revised: December 7, 2011

Suggested Citation

Edmans, Alex and Gabaix, Xavier, Tractability in Incentive Contracting (April 25, 2011). Review of Financial Studies, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1164342

Contact Information

Alex Edmans (Contact Author)
London Business School - Institute of Finance and Accounting ( email )
Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
University of Pennsylvania - The Wharton School ( email )
3733 Spruce Street
Philadelphia, PA 19104-6374
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
European Corporate Governance Institute (ECGI) ( email )
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Centre for Economic Policy Research (CEPR) ( email )
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Xavier Gabaix
New York University - Stern School of Business ( email )
Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY 10012-1126
United States
HOME PAGE: http://pages.stern.nyu.edu/~xgabaix/
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
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